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The AMT Is Neither a Flat Tax Nor a Fair Tax

Robert H. Nelson had an op-ed in yesterday’s Washington Post making the case for leaving the Alternative Minimum Tax unchanged, so that it becomes a de facto “flat tax.” (Nelson is the author of one of the most fascinating books about economics I’ve ever read (part of), but also a fellow at the much-in-the-news-lately Competitive Enterprise Institute, best known for defending poor CO2 against its enemies, foreign and domestic, and their fellow-travelers.)

There have been several other comments on the op-ed, and I almost let it go, but there’s more to say, because I worry that this is where we’re going: Republicans will argue that there’s no need for tax increases because revenues are going to go up naturally, and even in a progressive way (as the AMT, which is not indexed to inflation, swallows more of the middle class). I suspect that Democrats will also be tempted by the idea that it might be possible to avoid an actual political fight over raising revenues and let the AMT - which seems somehow “fairer” - work its magic.

Kevin Drum and Ezra Klein both picked on Nelson for his assertion that “There is wide agreement among economists on the benefits of a federal "flat tax" on income that would apply a uniform rate to every taxpayer and eliminate most current deductions and tax credits,” noting correctly that there is a big difference between a single-rate tax - on which there is not wide agreement and which in fact would not be fair - and a broad definition of income, thus eliminating many deductions and credits, on which there is somewhat wider agreement.

The problem with the ATM is that it is neither! It is not a flat tax, since what it does is graft two additional rates onto the existing five-rate system, and those two rates have altogether different rules associated with their definition of income. They are “flat” in that they are not marginal rates - once you trigger the AMT, you pay 26% or 28% on all your income, rather than 10% on the first $15,000, 33% on income over $188,000, etc. as in the regular system. But grafted onto the existing system, the AMT doesn’t make it flatter, it creates more complex marginal rates.

The AMT is poorly targeted. Although originally intended to curb tax sheltering, the AMT raises less than 5 percent of its revenue from anti-sheltering provisions, such as accelerated deprecation or oil depletion allowances. In 2010, only about 1 percent of AMT taxpayers will be subject to the tax due to anti-sheltering rules. A key reason why the AMT does not target shelters very well is that the preferential treatment for capital gains-the lynchpin of most individual tax shelters-is not curtailed by the AMT.

That last point is especially important: The big problem in the tax code right now - the uber-loophole - is the differential treatment of capital gains and dividend income, that is, income from investments rather than from work. They’re still protected, because the. As the AMT expands, it will expand this differential, as those who get their income from work will be affected and those who get more of it from investments are not. A middle-income working taxpayer in a higher-tax state will be hit by the AMT much sooner than someone living off the earnings of a trust fund and making more money, while lazing around a mansion in Miami Beach smoking cigars. (I use Miami partly because the AMT cuts out the deduction for state and local taxes, which is why it’s sometimes called a “Blue State Tax.” There’s a case for eliminating the deductibility of state and local taxes, but no logic for allowing it in the AMT and not the regular tax code.)

Letting the AMT take over the tax code is a really bad, dangerous idea. In the years ahead, there will be no alternative except to face up to the need to raise taxes and make the choices about the fairest way to do that.

I don't think the end of the sentence is missing. I believe it's just a typo that split off the end. It should probably read this way:

They’re still protected because, as the AMT expands, it will expand this differential, and those who get their income from work will be affected while those who get more of it from investments will not.

I'm with Nicholas -- on Zeno's reconstruction, it looks like the "because" is backwards (that is, it's because they're still protected that the AMT will expand the differential, not the other way around).

"In the years ahead, there will be no alternative except to face up to the need to raise taxes and make the choices about the fairest way to do that."

That's simply not true. The alternative is to cut spending, and we really don't even have to do that. We could just hold spending constant in real per-capita terms, which is what happened during the '90s, when it worked out pretty well. And even that's not absolutely necessary--as long as spending growth is less than GDP growth, we can eliminate the deficit and eventually retire the debt without ever raising taxes.